The Housing Market is Shrinking

The foreclosure headlines today are that one third of all home sales in Q2 were of distressed properties (foreclosures and short sales), according to a new report from online foreclosure sale and data site RealtyTrac.

The discount on those homes from comparable non-distressed properties was 32 percent.

What the headlines don't say is that while the percentage of the market that's distressed rose from a year ago, from 26 to 31 percent, the actual number of distressed sales fell. The share only went up because the number of non-distressed sales fell, leaving the total pool smaller.

And there's the biggest problem in housing today.

The granular, organic, whatever you want to call it…non-distressed market is withering away. Sellers are afraid to put their homes on the market for fear of losing too much equity, which means there are fewer potential move-up buyers. First time buyers are choosing to rent in droves, as unemployment and the wider economy recover far more slowly than expected. This, despite the fact that, nationally at least, it now costs about the same to rent as it does to own. Just look at where the mortgage payment-to-rent ratio has gone over the past few years.

Rent, as a percentage of income, is rising and household formation is slowing at an alarming rate, eating into that much-needed first time home buyer demand. The good news is that distressed sales are clearing faster, with streamlined short sales now making up a greater share of all distressed sales. Banks are getting rid of troubled loans/properties before having to go the more costly route to foreclosure.

Great, so all that inventory will go away soon, right, and regular housing demand will come running back! Not so fast. The pipeline of troubled loans is still huge, 4-5 million homes, and unfortunately new delinquencies are on the rise again. And then there's this problem: Households are getting bigger, as the current tough mortgage market spurs more multi-generational living.

Households had been getting smaller over the past decades, despite population growth. That was great for housing, because it meant more demand. "A one tenth of a percent increase in people per household would wipe out three years worth of population- and immigration-driven household growth," according to Green Street Advisors. That appears where we're headed.